Avery Products

(Financial Analysis)
Robert Eng, vice president and loan officer of the First National Bank of Cincinnati, was recently alerted to the
deteriorating financial position of one of his clients, Avery Products, nc!, by his bank"s newly instituted
co#puter$loan$analysis progra#! %he bank re&uires &uarterly financial state#ents balance sheets and inco#e
state#ents$fro# each of its #a'or loan custo#ers! %his infor#ation is punched on cards and fed into the
co#puter, which then calculates the key ratios for each custo#er, charts trends in these ratios, and co#pares
the statistics of each co#pany with the average ratios and trends of other fir#s in the sa#e industry! f any
ratio of any co#pany is significantly poorer than the industry average, the co#puter output #akes note of this
fact! f the ter#s of a loan re&uire that certain ratios be #aintained at specified #ini#u# levels, and these
#ini#u#s are not being #et by a co#pany, the co#puter output notes the deficiency!
(hen an analysis had been run on Avery Products three #onths earlier, Eng had noticed that so#e of the
co#pany"s ratios were showing downward trends, dipping below the averages for the 'ewelry #anufacturing
industry! Eng had sent a copy of the co#puter output, together with a note voicing his concern, to )ohn Avery,
president of Avery Products! Although Avery had acknowledged receipt of the #aterial, he had taken no action
to correct the situation!
%he first financial analysis indicated that so#e proble#s were developing, but no ratio was below the
level specified in the loan agree#ent between the bank and Avery Products! *owever, the second analysis,
which was based on the data given in %ables +, ,, and -, showed that the current ratio was below the ,!. ti#es
specified in the loan agree#ent! According to the loan agree#ent, the Cincinnati Bank could legally call upon
the co#pany for i##ediate pay#ent of the entire bank loan, and if pay#ent was not forthco#ing within +.
days, the bank could force Avery Products into bankruptcy! Eng had no intention of actually enforcing the
contract to the full e/tent that he could legally, but he did intend to use the loan agree#ent provision to pro#pt
Avery Products to take so#e decisive action to i#prove its financial picture!
Avery Products is a co#pany that #anufactures a co#plete line of costu#e 'ewelry products! n
addition to its regular #erchandise, Avery creates special holiday ite#s for the Christ#as season! 0easonal
working capital needs have been financed pri#arily by loans fro# the Cincinnati Bank, and the current line of
credit per#its the co#pany to borrow up to 1-..,...! n accordance with standard banking practices, however,
the loan agree#ent re&uires that the bank loan be repaid in full at so#e ti#e during the year, in this case by
February +222!
%AB3E +
A4ER5 PR678C%0, NC!
BA3ANCE 0*EE%
5EAR EN7E7 7ECE9BER -+
+2:: +22; +22< +22=
Cash 1 ;+,... 1 =+,... 1 ,:,=.. 1 ,.,;..
Accounts receivable +=-,... ,;<,... ,>>,;.. -::,...
nventory ,.;,... -.=,... <+.,... :,=,,..
%otal current assets 1;.:,... 1=+,,... 1 :+=,... 1+,,-;,=..
3and and building =+,... ;2,... +-.,=.. +,,,;..
9achinery :+,=.. +<+,... ++:,-.. +.,,...
6ther fi/ed assets ;2,... ,:,=.. :,,.. =,+..
%otal assets 1<22,=.. 1:;.,=.. 1+,.>-,+.. 1+,;=<,+..
Notes payable, bank $ $ +.,,... ,:=,...
Accounts and notes payable 2.,... 2:,... +<<,... -.=,...
Accruals ;.,:.. ;2,... <>,... >>,<..
%otal current liabilities 1+-.,:.. 1+;>,... 1 -+;,... 1 ==2,<..
9ortgage =+,... ;<,... ;.,:.. -=,>..
Co##on stock -=<,... -=<,... -=<,... -=<,...
Retained earnings ;,,:.. ,:-,=.. -<-,-.. -2-,2..
%otal liability and e&uity 1<22,=.. 1:;.,=.. 1+,.>-,+.. 1+,;=<,+..
%AB3E ,
A4ER5 PR678C%0, NC!
NC69E 0%A%E9EN%
+22; +22< +22=
Net sales 1,,=<,,... 1,,><;,... 1,,:<=,...
Cost of goods sold ,,+,+,=.. ,,,.-,,.. ,,,:;,:..
?ross operating profit 1 <-.,;.. 1 <<.,:.. 1 <>+,,..
?eneral ad#inistration and selling ,.;,... ,,;,;.. ,;;,:..
7epreciation :+,=.. +.,,... +,,,;..
9iscellaneous ;.,:.. :<,>.. +,,,;..
Net inco#e before ta/es 1 ,.;,... 1 +-:,>.. 1 :+,=..
%a/es @-<AB >+,;.. ;:,<;< ,:,<=.
Net inco#e 1 +-,,=.. 1 2.,+<< 1 <-,.;.
%AB3E - A4ER5 PR678C%0, NC!
)ewelry 9anufacturing ndustry
Ratios @+22=BC
Duick ratioE +!.
Current ratio ,!>
nventory turnover
b
>F
Average collection period -, days
Fi/ed$asset turnoverC +-!6 /
%otal asset turnoverC ,!= /
Return on total assets ++!>A
Return on net worth ,-!;A
7ebt ratio <.A
Profit #argin on sales ;!<A
ndustry average ratios have been constant for the past three years
a
Duick ratio e&uals Current Assets less nventory divided by Current 3iabilities!
b
Based on year$end balance sheet figures!
*igher costs, especially of #etals, as well as increased wages of skilled crafts#en, led to a decline in
Avery Products" profit #argin and net inco#e during the last half of +22< as well as during #ost of +22=! 0ales
increased during both of these years, however, due to the fir#"s aggressive #arketing progra#, despite
co#petition fro# shell and tur&uoise 'ewelry #akers!
(hen Avery received a copy of Eng"s latest co#puter analysis and the blunt state#ent that the bank
would insist on i##ediate repay#ent of the entire loan unless the fir# presented a progra# showing how the
poor current financial picture could be i#proved, he began trying to deter#ine what could be done! *e rapidly
concluded that the present level of sales could not be continued without an increase in the bank loan fro#
1-..,... to 1;..,..., since pay#ents of 1+..,... for construction of a plant addition would have to be #ade
in )anuary +22>! Even though Avery Products had been a good custo#er of the Cincinnati Bank for over <.
years, Avery began to &uestion whether the bank would continue to supply the present line of credit, let alone
increase the loan outstanding! Avery was especially troubled by the fact that the Federal Reserve 0yste#
recently had tightened bank credit, forcing the Cincinnati Bank to ration credit even to its best custo#ers!
QUESTIONS
+! Calculate the key financial ratios for Avery Products, nc!, for each year and ratio suggested in the
caseGs industry averages! AnalyHe the trends for each ratio!
,! (hat strengths and weaknesses are revealed by the ratio analysisI
-! (hat a#ount of internal funds would be available for the retire#ent of the loanI f the bank were to
grant the additional credit and e/tend the increased loan fro# a due date of February +, +22>, to )une -., +22>,
would the co#pany be able to retire the loan on )une -., +22>I *N%J %o answer this &uestion, consider
profits and depreciation as well as the a#ount of inventories and receivables that would be earned if Avery
Products" inventory turnover and average collection period were at industry average levels, that is, generating
funds by reducing inventories and receivables to industry averages! Also, round +22= sales to 1,!2 #illion in
answering this &uestion!B
;! 6n the basis of your financial analysis, do you believe that the bank should grant the additional loan
and e/tend the entire line of credit to )une -.,+22>I
<! f the credit e/tension is not #ade, what alternatives are open to Avery ProductsI
=! 8nder what circu#stances is the validity of co#parative ratio analysis &uestionableI